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Unsecured Creditors May Collect Post-Petition Attorneys’ Fees But Undersecured Creditors May Not
Lending & Restructuring Alert
November 2009
Authors: Paul A. Rubin

The Second Circuit Court of Appeals has just held that an unsecured creditor in a bankruptcy case is entitled to recover, as part of its pre-petition claim, attorneys' fees it incurred post-petition pursuant to a pre-petition contract with the debtor. 

This ruling is somewhat counter-intuitive. It is well-established that an oversecured creditor—whose claim is less than the value of its collateral—may collect its post-petition attorneys' fees from a debtors' estate.  Under this ruling an unsecured creditor now has the same right. But an undersecured creditor—whose claim exceeds the value of its collateral—is not permitted to collect such fees.  You would expect that an undersecured creditor would have at least the same rights as a wholly unsecured creditor.  But this ruling actually places the unsecured creditor in a better position than an undersecured creditor when it comes to collecting attorneys' fees incurred post-petition.

You might also think that allowing an unsecured creditor to collect post-petition attorneys' fees based on a pre-petition contract would unfairly disadvantage other creditors, such as tort claimants, whose distributions may be reduced as a result of this holding. But the court said that when equally sophisticated parties negotiate an agreement that provides for the recovery of collection costs upon default, the presumption is that the creditor gave value in return for that right.  In the court's view the provision compels the parties to adhere to their original deal.

This holding by the Second Circuit (whose rulings bind the federal courts in New York,  Connecticut and Vermont) follows a similar ruling issued earlier this year by the Ninth Circuit Court of Appeals (whose jurisdiction includes California and eight other West Coast states).  But other courts, including the First Circuit Court of Appeals (whose decisions bind the federal courts in Massachusetts, Maine, New Hampshire and Rhode Island), have reached the opposite conclusion.  It would not be surprising if, at some time in the future, the United States Supreme Court steps in to resolve this split, especially since these conflicting decisions address an issue that the Supreme Court identified but did not answer in an opinion it issued in 2007.  In the meantime, the ramifications of this decision must be recognized.

What This Means For You

All unsecured creditors should seek to include: (i) provisions in their contracts for attorneys' fees they may incur while seeking to collect amounts due to them thereunder, and (ii) post-petition attorneys' fees as part of their bankruptcy claims when permitted by their contracts. 

Bankruptcy courts are likely to reject such claims to the extent the fees sought are deemed to be "unreasonable."  Disputes over whether such fees are reasonable are easily foreseeable.     

This decision will make it more expensive, and thus more difficult, for debtors to confirm plans of reorganization that propose to pay all creditors in cash in full since now attorneys' fees of unsecured creditors must also be paid.  But in cases where debtors propose "pot plans," which distribute a fixed amount of money pro rata among all unsecured creditors, the impact will be felt primarily by those creditors who are not entitled to recover attorneys' fees.

For more information please contact Paul Rubin at (212) 592-1448 or prubin@herrick.com.

Copyright © 2009 Herrick, Feinstein LLP. Lending and Restructuring Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.